Where to Pass the Hard Brexit Hot Potato?

Put yourself in the shoes of an international investor. First, the UK voted to leave a longstanding trade agreement with its biggest trading partner. Like everyone else, you were shocked. This trade agreement had accompanied a period of relatively robust economic growth – Britain had certainly not been an economic loser. Moreover, you may have committed capital to the UK precisely because you regarded it as a bastion of free trade from whence to attack the markets of its socialist-legacy neighbours. You now have to rethink.

As a foreign investor, you are completely dependent on the pragmatic, British political system to sort all this out. It needs to plot a path that does the least damage to society and the economy, and that hopefully re-establishes the former status quo as much as possible (so you can re-establish your positions or gain back your foreign currency losses). When Theresa May proposed a Brexit strategy that dared to speak the unspeakable – that the UK might crash out of Europe on nothing better than WTO terms – that system failed you again.

The general election promised to stabilise the approach to Brexit or, at worst, to make things no worse. It failed. It has made the situation more complex, creating a kaleidoscope of shifting arrangements, electoral strategies, what-ifs and feedback loops. On the one hand, foreign investors can see that the election is a blow to the Prime Minister’s hard vision of Brexit but, on the other, there is the heretofore inconceivable prospect of a quasi-socialist Labour government. Moreover, the confusion and delays imperil the negotiating process itself, with much to be accomplished and time ticking away. Whichever path Britain takes, it is going to be disorderly. Thus, Sterling is suffering a minor crisis of confidence.

Looking through the immediate turmoil, however, some uncertainties have actually been resolved. The simplistic question asked by the EU Referendum attracted people from both sides of the political divide but, naturally, different political viewpoints want different outcomes for the post-EU era. Even ignoring the 48% who voted to remain, party lines persist among the 52%. The nature of the post-EU era will be determined largely by the form of Brexit. So whether it’s ’soft‘ or ’hard‘ is of critical importance. Theresa May tried to ignore that distinction, believing she could craft a deal after her own view of what Britain should look like. In so doing she encouraged significant electoral opposition. Now she (or another leader) will genuinely be answerable to Parliament, and Parliament has always been soft on Brexit.

As in Macbeth, “things bad begun make strong themselves by ill” and the election is merely another step in the painful process by which the British political system digests the EU Referendum’s implications. The Great Repeal Bill has to pass Parliament and the House of Lords. That’s difficult enough. But Brexit must also not damage the economy to the extent that that there is an electoral backlash (presumably in 2022). No one knows how much damage a hard Brexit would cause, but it is not zero. Jobs, somewhere, would be lost before others could be created. And jobs, somewhere, would be lost even if others were created. At best there would be both winners and losers. A soft Brexit, on the other hand, could probably be accomplished without any significant change in the economy.

The government could choose to soften the path of Brexit, minimising risk to the economy (and to itself), or it could try to share the risk of a hard Brexit with the opposition via a cross-party approach. For the long term good of its own party, the Labour Party should resist risk-sharing. In any case, the opposition has bigger fish to fry. It can now see the possibility of electoral victory, and will do anything it can to destabilise the government. Its best hope is that the government continues to pursue a hard Brexit, makes a mess of the negotiations, makes a mess of the economy, alienates pro-EU backbenchers and loses public support. That is why the government’s best strategy is to soften the path of Brexit. This would alienate the notorious hard Brexit backbenchers, but it is the least-worst option.

Some urgency is added by the fact that British economic growth is slowing. Inflation has surged on the back of the collapse in the value of Sterling and that inevitably eats into people’s wealth. Should this weakness become more pervasive − while our neighbours’ economies are doing relatively well − it will inevitably be blamed on Brexit. Many Leave voters were sold on the idea that leaving the EU would make Britain wealthier, for example by cutting red tape or because the EU budget contribution would become available to spend on the National Health Service.

Voters have notoriously little patience for economic harm (irrespective of their views on immigration) and they will turn against Brexit in droves if it becomes clear that it makes them poorer. They will either blame the Leave campaigns for deluding them or criticize the government for its handling of the project. At this point, an incumbent government would face the prospect of championing a bill that would probably be rejected in Parliament and would be widely despised, while taking the blame for economic hardship. In such a situation, MPs would turn against their leader rather than face annihilation at the polls next time around. No political party can run that risk.

For the long term good of the country, both parties should come together − a project as enormous as Brexit should go beyond party politics. This is very unlikely to happen, of course. But, even if it did, it would only be remotely feasible with a soft Brexit, which could be forced through Parliament over the heads of a minority of MPs. Brexit is at a turning point, one that will ultimately reduce the risk of Brexit to the parties executing it and, indirectly, to the British economy. Brexit is softening.

Seven Investment Management LLP is authorised and regulated by the Financial Conduct Authority. Member of the London Stock Exchange. Registered office: 55 Bishopsgate, London. EC2N 3AS. Registered in England and Wales No. OC378740.

More From MarketViews

Sponsored Financial Content

Seven Investment Management helps individuals and families manage their capital to meet their financial goals and aspirations. In 2002, we set up our business to do things the way we think they ought to be done. We now look after around £11bn of clients’ and our own money, which is invested alongside. We’re careful on cost and big on service. We do things simply and well. We call it radical common sense.

More from Seven Investment Management

dianomi Sentifi Most Talked About British Companies

Latest from MarketViews

Join the MarketViews Community and get the latest views from the experts on what’s happening in the markets direct to your inbox.

E-mail*

By providing your email address, you consent to receiving further information from MarketViews. You can unsubscribe at any time and all information provided is governed by our Terms & Conditions and Privacy Policy

Should be Empty:

Polls

What is your general market sentiment for the second half of the year?